Tipping Points

An article today in the Denver Post reminded me of an article I read last week about tipping points. A tipping point is a specific event that changes the course of history. Most of the time, tipping points are identified after the fact.

A couple of examples might help clarify what a tipping point is. Right before the start of the Civil War, the South announced that they were seceding from the Union. This was in response to large tariffs that were imposed by the government on exports of commodities by the southern states. As most of you know from your history studies, the right of any state to secede was instrumental in convincing the states to ratify the constitution. Lincoln's proclamation of war to prevent the South's secession is seen today as a major tipping point in the balance of power between the federal government and state's rights. (And no, slavery was NOT the primary reason we fought the Civil War, it was just a convenient PR plan to detract the citizens attention away from the secession issue.)

Another more recent tipping point is the events of 9/11. With that event, the rights of innocent Americans was severely undermined in an effort to protect us from terrorists. If you read through the Patriot Act you will be amazed at what the government can do to you or I without a search warrant.

Ok, hopefully you understand what a tipping point is and how these seemingly random events can sway human history. A recent article by Jim Puplava of Financial Sense Online, details what he sees as six tipping points that could cause the economy to fall. To that list I would like to add a couple of non-financial tipping points that could cause the economy to tumble over the edge.

That brings me back to the article in the Denver Post this morning. It was a short article buried in the middle of the paper. I searched the online version of the Post and could not find it. The basic premise of the article is that a scientist has come out with a prediction that the world will reach peak oil production sometime this year or next. I discussed the term “Peak Oil” in an earlier post here. The significance of the article this morning is that what has been discussed in alternative news media outlets is now starting to seep into the mainstream news media. This is significant because this seeping or slow changing of opinions about our current oil situation is the tip of the iceberg. And as this becomes more pervasive, it will begin to weigh on everyone's mind. This is my first tipping point. The point in time when the general population begins to awaken to the fact that we have a limited amount of oil and things are going to get a lot worse before they get better. This awakening could easily send the economy over the cliff.

The second possible tipping point is some type of climactic crisis. We have all been reading the stories from around the world detailing unusual weather. A February article by Michael McCarthy of the Independent reports that the findings of the Cambridge-based, British Antarctic Survey shows that a massive Antarctic ice sheet in disintegrating at an alarming rate. The collapse of this ice sheet could raise sea levels around the world by 16 feet. Imagine what that would do to the coastal areas around the world. Most of the U.S. refineries would be under water as would several cities.

The third possible tipping point has to do with a major terrorist attack on U.S. soil. I believe of all of the possible tipping points, this one is probably the most remote, but it has to be considered. Some type of biological or radiological attack on a major metropolitan area would be devastating to this country and would no doubt plunge us into deep recession or worse.

Now, in addition to these three non-financial tipping points, Jim's article discusses six financial tipping points that I will briefly summarize here. (Go here to read the entire article and study the accompanying charts that help clarify his position.)

Tipping Point 1: Leveraged Carry Trade. Briefly, the carry trade is a practice by speculators and hedge fund operators whereby they borrow money at the current short-term rates and lend it out at the higher long-term rates. As long as the difference between short-term rates and long-term rates remains high enough, these traders make money, and lots of it. What is happening right now is that the rate differential is narrowing and this is putting profit pressure on these speculators forcing many of them to “unwind” their positions. If this unwinding accelerates, liquidity dries up and hedge funds will not be able to liquidate their positions and will suffer catastrophic loss. Imagine an event like the Long Term Capital Management collapse in 1998 magnified by 100 times. The world financial system would lock up.

Tipping Point 2: Growing Trade Deficit. The current trade deficit continues to grow with no signs of slowing. It looks like the deficit this year will exceed 2004's record of $617 billion. While you and I continue to purchase all sorts of items at our local Wal-Mart for great low prices, we are putting our manufacturing sector out of business. In effect, we are shipping our production overseas where labor costs are lower. This has created huge imbalances in our economy that sooner or later will have to be dealt with. Bottom line is that we are going to see price inflation of imported items and a continued reduction in high paying manufacturing jobs.

Tipping Point 3: U.S. Consumer Debt. We as a nation are in debt up to our eyeballs. Since 2000 consumers have added debt to the tune of $3,246.2 billion. That's a lot of debt. Not only are we borrowing more money, we are spending more than we make at an increasing rate. I believe that the U.S. consumer has, by itself, keep the U.S. economy limping along for the past 5 years. To keep the game going, housing prices have continued to climb allowing consumers to borrow more and more on their houses. Interest rates have been held down by the Federal Reserve, which has helped homeowners to afford more and more debt. And the increase in popularity of adjustable rate mortgages has allowed homeowners to buy bigger homes and take out larger loans that they could ever afford with a conventional loan. The only problem…when, not if, rates start rising, millions of homeowners will not be able to make house payments. Wave bye-bye as the economy disappears into the abyss.

Tipping Point 4: Banking Crisis Ahead. Just two weeks ago, banking regulators issued a warning to U.S. banks to tighten up their lending standards. It seems that bankers are making some of the same mistakes that Savings & Loan companies did back in the 80's. The difference this time is everyone is involved in home mortgages, banks, insurance companies, credit unions, and thrifts. Not only is everyone playing the game, but there is almost no equity in any of these properties. And the equity that a few of the properties have now would completely evaporate if the housing market suffered a 10% price contraction. Lending institutions are in an extremely vulnerable situation right now and as Jim puts it so well in his article, “If we aren't at the edge of the cliff, we are certainly close.”

Tipping Point 5: Reliance on Foreign Investors. Currently, more than 44% of our outstanding government debt is held by foreign governments. In fact, our government has to sell close to $60 billion dollars in bonds every month just for our government to meet its obligations. In other words, these foreign countries, most notably, China, Japan, Korea, and Taiwan are carrying us on their dime. And now we are hammering China to revalue their currency. All that will do is cause our cost of buying foreign goods to increase. All I can say is we better be careful what we ask for. We just might get it.

Jim's final Tipping Point is called the Rogue Wave. If you saw or read The Perfect Storm, you know that rogue waves happen with no advance warning. They are the result of random events and when they hit, they are devastating. Basically, the rogue wave tipping point could come from any sector. There are so many imbalances in our economy right now that any one of them could set events in motion that literally changes the course of history. In addition to financial tipping points there are a lot of political hotspots around the world that could set off a firestorm that would take down our economy.

The goal of bringing to light all of these factors that could play a pivotal role in the direction of our economy in coming months is not to cause a panic or severe depression. It is to alert you to what could happen. Hopefully, by paying attention to these areas, you may have a little notice of impending crisis and take appropriate defensive steps. A little notice is more notice than 99% of the population will get. Most will never see it coming until it hits. Don't allow yourself to be a part of that group.